Channel hopping

20 February, 2006

SOURCE: Flight Airline Business

The balance of power in the distribution world is shifting as carriers, which once had little or no influence over their distribution outlets and costs, begin to exert more authority over the sale of their product

It was supposed to have been a year of revolution, a year in which a new generation of tech-savvy upstarts replaced and reshaped the old order and hastened the extinction of dinosaurs. It didn’t happen. The dinosaurs in the shape of Global Distribution Systems (GDS), which had learned to dance while pundits declared their obsolescence, nimbly avoided destruction and fought back. The limits of the revolution became clear and the meat over which the old guard and the upstarts had been fighting – the airline – learned to hunt for itself.

The carriers had little choice: GDS costs are 2.5% of revenues at some, for example about $165 million a year for Continental and $500 million a year for American Airlines. Trimming those totals is high on chief executive checklists. As David Cush, American’s sales vice-president and its distribution guru puts it: “Driving down distribution costs is top of the mind with Gerard [Arpey, American’s chief executive]. With him and the other executive team members it is perhaps more important than driving the cost of fuel in the larger scheme of things. Fuel, after all, is not controllable but distribution is.”

Richard Eastman, a California-based industry consultant who was an early designer of distribution processing systems, says: “The competitive imbalance of distribution costs has finally surfaced as a meaningful number as the legacy carriers have got labour and benefit programmes in line with the low-cost carriers.”

New-technology lower-cost alternatives came about precisely because of a crying need for a cheaper distribution channel and seems to have arrived at a critical juncture. The net-enabled upstarts, which a year ago were dubbed GNEs for new Global New Entrant Systems, gained public and industry attention and they certainly put the world on notice (see related story on page 49). As Norm Rose, a 25-year veteran who is a principal of PhoCusWright consultancy, says of the GDSs, as they looked at the new players: “They know they have to change and they are changing.”

Indeed they have, investing enough in technology to handle some 55 million tickets a month worldwide while offering airlines new pricing menus that replace the one-price-fits-almost-everyone mould with as many as six tiers of fees crafted to the airline’s business. They have won back customers who deserted them like AirTran or US Airways and won deals to display and sell more of an airline’s offerings than before, as Worldspan just did with KLM.

The GDSs have even won back the very customers who were supposed to desert them in favour of the new contenders. Northwest Airlines, the noted cost-cutter and the most outspoken supporter of the newest GNE, agreed to return to a distribution agreement with Sabre. Instead of further litigation with the distributor, Northwest locked in its content and GDS pricing for five years. It was the first contract renewal by a major US legacy carrier with a traditional GDS since the revolution began and since US distribution was formally deregulated. The parties released no details of the agreement, but Northwest’s vice-president distribution and e-commerce, Al Lenza, who was the leading critic of rising GDS fees and most vocal champion of the new entrant alternatives, stated that the contract “achieves Northwest’s distribution objectives”. Rose called this “a real landmark decision”.

A new distribution order

The new deals have upset the old arithmetic: a GDS booking back in the bad old days cost an airline as much as $12, a cap that became but an all-too frequent cost despite volume deals that were supposed to bring the sum down. The GNEs came out saying that they could get this down to $2 or $3 a transaction. The GDS cost is falling too, with the Sabre/AirTran deal reportedly bringing the cost down to just over $5 a ticket. That $5 figure is close to what airlines say it costs them to sell a ticket on their own website, which is about $3 when all costs are considered.

The new GDS deals are different also in that they are five-year contracts, rather than the three-year pacts like the so-called Direct Connect Agreements (DCA) they replace. These were signed as the distribution revolution was beginning and were intended as a transition to the new age. For Sabre, the Northwest, US Airways, and AirTran deals are a vindication of its ability to offer airlines enough channels in a single package deal that is economically palatable.

Sabre senior vice-president Tom Klein said after these renewals began: “This will be a year of noise and news. Noise from others, but you can also expect to hear substantial news from us this year.”

In Europe, SAS is using the prospect of supplying its new distribution platform as a carrot to tempt the GDSs to be more radical on costs in the short-term. With a high proportion of its traffic on short-haul European routes, relative to other players like British Airways or Lufthansa, SAS could not put up with distribution costs that had risen from 1-2% per ticket a couple of years ago to 5-6% today, says Robin Kamark, SAS senior vice-president airline commercial.

Discussions with GDSs had not been fruitful, says Kamark, so it went for the nuclear option. “We said enough is enough and wrote to them to say that if we cannot come to an agreement to have a reasonable GDS cost compared to direct links or our own website that we will pull content. We were not in favour of moving away from the GDS, but we were upfront and honest about it.” It laid down a deadline of 1 October when it would seek alternative distribution for the Scandinavian market where SAS is facing fierce competition from low-cost carriers.

With around 50% of its bookings made via the GDS this was a radical move, and it was the spur required for the largest GDS in Scandinavia, Amadeus, to agreed to a new deal. The pilot scheme delivers an unspecified “significant reduction in booking charges in the Scandinavian market,” says Kamark. In exchange, SAS gives Amadeus its full content. Since this deal, SAS has signed similar arrangements with the other GDS.

The SAS pilot is the third such deal Amadeus has signed, adding to those it has with BA and KLM. But three is enough for the time being, says David Jones, executive vice-president commercial at Amadeus. “Now we will pause and have a period of assessment. These are pilots and that is how we position them.” He is far from certain this model is the way forward, believing instead that its recently extended value pricing model is a better prospect.

“For this to be a possible new model all three parties have got to get comfortable around this,” says Jones. “In some markets we are comfortable, in some we are not. This says to me it is not a fully generalisable approach.” The main issue is that travel agents have to pay a fee to Amadeus for access to these fares, rather than payments going the other way as used to be the case.

Access to low-fare content

“I believe the pilots are really about accelerating the value pricing approach, which really seems to be working,” says Jones. The latest version of value pricing offers carriers a substantial extra discount for low-fare content if Amadeus has full content, including web fares. The discount has increased to 45 euro cents (¢54) per segment from 25 euro cents. Amadeus has also added a third price band – geographic region in addition to home market and non-home market – to value pricing. It is an approach that has caught on with Sabre and Worldspan too. “This is very encouraging because it has stood the test of time,” says Jones. “It’s what we think is the real answer to this problem. A further evolution of value pricing looks more promising to me than an evolution of the SAS model.”

The next move for Amadeus is more itemisation of products normally all contained within the transaction fee. “We have started charging separately for a limited number of services, for example revenue management products, but are doing it very cautiously,” says Jones.

The tipping point for change for SAS was the muscle it was able to exercise. Northwest’s support for G2 Switchworks, one of the new distribution players, was an historic example of leverage achieving its desired results. While these alternatives are clearly more than just leverage, the airlines themselves, as increasingly direct sellers, have leverage of their own.

Airline moves to direct connect options have put the GDSs into play for another outlet – the online and traditional travel agencies. It is now the GDSs, the intermediaries, rather than the airlines, that are fighting for business from the likes of Expedia or American Express.

One airline pioneer in direct sales, Continental, celebrated the 10th anniversary of its website in March. John Slater, its head of distribution says: “Continental.com is growing. It surpassed $2.3 billion on sales, gets 25% of domestic sales and 19% of system sales; we see no limits on its growth and $3 billion in sales in 2006.” At American, Cush, like distribution genies at major US carriers, says that the cost-savings push, combined with the direct trend, may lead this year to a possibility that was until now unthinkable: “We have decided that we do not absolutely have to be in all four. A thought that goes through our negotiations is that maybe we need two or three” of the four traditional GDSs.

How will the choice be made? It is not, as the new entrants had once proclaimed, a choice in which technology is the sole criterion. As Eastman puts it, the GDSs have done a good job “of preparing for the transformation in a technology perspective. While each of the major GDSs has approached the problem differently, they appear able to respond in whatever direction the airlines decide to go.” Cush says: “The criteria are economics and which GDS provides support to our most important customers and agencies,” although he declines to specify if support covers incentives or other economic factors.

Cush is blunt about the new weapon in the airline bargaining arsenal. A key factor in American’s negotiations and key leverage “is the enormous growth in direct bookings on our own site. The bigger it gets, the faster it grows. It has grown at 56% in year over year rates and is now at 25% of total bookings by revenue. We have seen a significant increase in consumer willingness to buy direct, not just at aa.com but throughout the travel industry. It costs little to expand our site but we are willing to spend whatever it takes.”

Slater at Continental says that the low-cost carriers have introduced shoppers to the buy-direct habit. “The low-cost carriers that never were big in the GDSs, such as Southwest and JetBlue, helped cultivate the habit of going direct to the supplier – the online travel agencies are losing that traffic.” The direct sites have formed a new genre of direct connect deal, entirely different from and far more opaque than the US DCAs. For instance, both American and United offer direct corporate-booking online portals. These seem to be in-house products but in fact rely on the Cendant Orbitz unit. Cendant officials have said that the deals are not linked to Galileo GDS deals with those airlines.

SITA estimates that about 255.7 million people travel each year on direct online bookings made with the world’s top 20 airlines – saving almost $900 million in GDS fees for these 20 carriers alone. For all airlines, the saving is $1.2 billion, estimates SITA.

That is revenue that will likely never come back to the GDSs. They may have shown that they can live on a fairly drastic diet and still thrive, but even that toned-down prosperity could in the longer term be at risk. As Eastman puts it: “The GDSs’ problem is that no matter which direction the airlines do decide to move, the primary revenue stream of the GDSs will erode. Over time, so will the costs as the technology platforms are replaced, but the transition will be painful, very painful.” ■

DAVID FIELD / WASHINGTON AND MARK PILLING / LONDON

Online sales pile up

The North American market may not have been the first to adapt to the Internet, but it is the largest air travel market, and once it did, the adoption took with a massive momentum that will drive online sales of travel from 30% of bookings this year to about half by 2008, projects PhoCusWright consultants.

The US is now the world’s largest broadband market, with 34.3 million households, according to Parks and Associates research, while 65 million Americans book travel online, according to the Travel Industry Association of America. Henry Harteveldt of Forrester Research predicts that leisure travel alone booked online this year will be worth about $75 billion.

In the complex world of airline distribution here is a simple challenge for the industry – reduce transaction fees to zero. The idea is brought up not by the airline community, which has been beseeching GDSs and their mandatory annual fee increases to lower the cost of selling tickets for years, but by a GDS itself. “The challenge for Galileo and airlines is a direct conversation trying to figure out how to have a zero distribution cost,” says group vice-president Bryan Conway of Cendant.

This is a dialogue Cendant has been having recently with an airline partner. “We’ve created a model and demonstrated that it can be done. It requires a massive commitment and mindset change on both sides and requires airlines to stop seeing GDSs as an enemy or as a cost,” says Conway. “The essence of the approach is identifying alternative revenue streams for the GDS and in some cases sharing that revenue with the carrier.”

“It is possible,” believes Robin Kamark, senior vice-president airline commercial at SAS of the zero percentage transaction fee, who believes the trend is in this direction. “However, is it free of charge? I doubt it.” Carsten Kroeger, sales director at Air Berlin, welcomes any move to lower distribution costs, but is skeptical. “If the GDS partner is offering zero costs they have to find another system to get their money somewhere else.”

But Conway is adamant that it will be possible within five years. “In a GDS environment the transaction fee is still well over 90% of the total revenue stream of most bookings.” Its strategy is to reduce that dependence significantly to the sale of content from its many travel-related products.

While low-cost carriers rely as much as possible on their own websites for sales, they haven’t frozen out the Global Distribution Systems (GDS) completely, who are keen to capture their growing content. The key to winning this business is to offer connections to the GDS at a lower cost. Cendant, for example, has had a Basic Booking Product for several years, but that for some was still not cheap enough.

Now Cendant offers a new cheaper technological solution, an API (Applications Programming Interface) product that allows a Galileo travel agent to connect directly to a low-cost carrier’s website, avoiding the complexity and cost of full Galileo participation. “The critical part is that we have moved away from our dogma that we have to own the content – we are happy to get it from elsewhere,” says group vice-president Bryan Conway. Cendant, for example, has around 30 low-cost players connecting in some fashion to its Galileo GDS.

Amadeus says it has some 35 low-cost players on board and is poised to announce its own API solution with pilot deals with two carriers. Some, like Germany’s Air Berlin, which sells around 40% of its seats via travel agents using GDSs and a tour operator booking system, consider them an essential part of the sales mix. “My main goal is to sell the seats, not say to customers where they have to buy them,” says Carsten Kroeger, sales director at Air Berlin.

In Europe, Air Berlin is the one of the largest low-cost carriers that distributes using the GDSs, but neither of the big two – easyJet or Ryanair – has signed up yet, following the lead of their US role model, Southwest Airlines. Ryanair will not even give a GDS salesman an audience, but easyJet, with its stronger business market, is considered more likely to succumb.

In the US, GDS progress with low-cost carriers has come in part because the “big four” have been willing to make themselves part of the mix rather than the dominant channel. AirTran Airways, for instance, has been an aggressive mixer, recently adding both Worldspan and Sabre back into its blend, signing with aggressively exotic channels like Kayak.com, the travel search engine, and renewing with the granddaddy of alternatives, Navitaire’s Open Skies. But the economics must be there: Sabre won the business of the new US Airways on terms that were attractive enough that predecessor America West halted its ambitious work-in-progress to build an in-house system.

AirAsia widens its sales net

For the GDSs, bringing low-cost carriers into the fold is essential as they strive to build content. Malaysia’s AirAsia was courted for a year by various GDSs, says Kathleen Tan, executive vice-president commercial, and has signed to become the first to use Cendant’s API solution outside North America. The time to bring in GDS distribution began to look right as it expanded into countries like Cambodia, China, and Macau where travel agents remain popular, says Tan. AirAsia wanted this business, but not at any cost. It demanded, and got a system that had no upfront costs, no commissions, a minimal per-segment fee and immediate customer payment, says Tan.

For Italy’s MyAir, another new Cendant API-user, “a key part is that the booking does not go through the IATA clearing system – I get my money in 24 hours,” says Andreas Guenthard, the carrier’s distribution & commercial IT director. For a short-haul ticket sale using the new solution, the transaction fee per segment costs the airline from $1 to $1.50 compared to more usual $5 cost.